Tuesday, October 2, 2012

Will the Government Bailout Student Loans?

John Goldman emails and says, there will be nothing beyond some backdoor mini-bailouts:

Robert, your post about Student Loan forgiveness prompted this response.

As a heavily indebted graduate from two of America's Finest Institutions of Higher Learning(TM) I agree with your conclusion that there will be no overt bail out or wholesale early forgiveness of student loans.

Based on many conversations I've had with colleagues and others similarly situated, my observations are similar to yours. Most who I speak to believe there's a better than even chance of a student loan bailout sometime in the future. They feel that once the default rates get bad enough there will be a massive Federal effort to bail them out. Again, I think they are wrong on a couple of fronts because of the way the debt is held, and the degree of visibility a bailout would take.

First, the Feds own the vast majority of new student loan issued and are steadily accumulating the holdings of private originators/lenders. Zerohedge ran a series of charts that illustrate the increasing magnitude of the problem. Charts 30, 31, 39 show the growth in Federal ownership of these 'assets' and default rates over time.

Source: http://www.zerohedge.com/news/2012-09-28/student-loan-bubble-19-simple-charts

Second, the reality is Congress, the DoE, and the Treasury have already initiated back door bailouts of student loans. Several repayment programs exist to reduce the monthly payments made by borrowers. The most flagrant (I believe) is the Income Based Repayment plan (IBR). Under these programs 15% of 'discretionary income' is made on the loan regardless of how much is owed. Forgiveness under this program happens after 25 years for those who took loans out before July 22, 2014.

In practice a repayment plan such as that will never pay off the principal after 25 years based on those repayment schedules. That's a bailout. But that's not going to be enough to keep things together for many borrowers in the future. Legislation was made to accelerate changes made to the repayment programs. Now loans taken out after July 22, 2014 on the IBR plan will be forgiven after 20 years. Also, on July 1, 2014 the maximum IBR payments will be reduced from 15% of discretionary income to 10%.

Source: http://www.whitehouse.gov/the-press-office/2011/10/25/fact-sheet-help-americans-manage-student-loan-debt

Moreover, the Treasury is offering consolidation programs to reduce the interest rates on the loans by .50% if you move the loans onto the Fed's books. For someone like me with a ton of debt (150k+) from a law school education, it works out to an entire month's worth of payments from that reduction alone. That's a bailout.

Also, working for Government or 501(C)3 groups for 10 years making on time payments will grant loan forgiveness. As it stands right now, the amount of forgiveness granted under this plan is qualified as a 'tax event' by the IRS and is treated as income. That can be a significant amount of money to pay taxes on but if you work for the Government, IRS rules say no 'tax event'. There is work going on in Congress to eliminate the tax event for everyone.

These programs are in addition the current $2,500 maximum income tax deduction for student loan interest paid during the fiscal year.

And before we conclude that the Feds are serious about getting paid back, at least in real terms, there continues to be rumblings of additional measures that will reduce the burden on debtors. For instance, this legislation with many sponsors:


Some highlights include capping rates at 3.4%, 10 years of payments of 10% of discretionary income, reduce public service forgiveness to 5 years. Also, this proposal would retroactively apply for those who have made payments before enactment, effectively wiping out anything that remains for many long term payers. Most importantly when a catchy slogan is added to help sell it, the 10-10 Plan, I think it's a more serious proposal than others give credit.

I'm doubtful anything will happen in this session or even the next one, but it's unlikely to go away as the problem grows. What may be the biggest obstacle to a traditional bailout or Hansen Clarke's legislation is getting politicians to recognize there is a problem in the first place. For more than a generation politicians, teachers and parents have been pounding the drums about the importance of a college education. Introducing and passing this sort of legislation would serve as an admission that so many people were wrong for so long, and that's the last thing anyone wants to admit.


  1. Hey, these backdoor mini bail outs aren't so mini. Don't forget that with inflation at 6% or more, those debts will be inflated away in 10 years.

    1. Except that currently hundreds of billions in loans carry interest rates over 8%. Even the lower yield stuff is currently 6.8%.

      Also, a lot of older students (myself included) carry some vintage private debt from before the Federal take over. Almost all of it is variable based rates. Those rates are currently very small ~1-2%. But if rates creep up as Robert expects those loans are going to be like subprime all over again. Furthermore if the lenders like Sallie Mae raise their rates to maintain a real return those loans will out pace the inflationary increases.

      I agree that inflation will ease the burden on the loan payments but it will still be painful for hundreds of thousands of people.

      Also, with the direction the country is taking, the availability of jobs and entrepreneurial opportunities will continue to shrink, making debt service more and more difficult.

      The current unemployment rate as of August for 16-24 year olds according to the BLS is over 17%. And the younger those people are the more debt they will accumulate if they go to college. Tuition's are rising everywhere like crazy.

  2. I think what you'll see is the Feds purchase the outstanding student loan bonds off the balance sheets of the banks and hedge funds. Once that happens you basically owe the government money. They're never going to forgive that debt. The 15% income based repayment plan will act as a income surtax. This is going to be permanent tax increase for a generation of Americans who fell for the "education is the most important thing" garbage. It'll be really sad actually. That 15% was going to be their capital savings for retirement and other purchases. Not going to happen. Doomed to a life of undersaving.

    1. Two very very good points.

      "They're never going to forgive that debt." Nope not a chance.

      "That 15% was going to be their capital savings for retirement and other purchases." Or method of saving for entrepreneurial ambitions.

      From the Austrian perspective this arrangement will only exacerbate America's problems. As capital is diverted away from savings and productive activities and into government waste operations.

  3. Doomed to a life of servitude